We are back after taking 2 weeks off and we hope you enjoyed your holidays. In our most recent blog, we looked at passing on the family business. We discussed how important it was to get a proper valuation of your company. We then went on to look at an example of a way to pass on the business and get some cash out. In the example we gave there were some hurdles to overcome. The son had to secure funding from and external provider. He also had to set up his own holding company to buy the shares. In case you missed it Read here
This week we look at a different approach to achieve the same result. The son gets the family business and the dad gets some cash out. We will achieve this result without some of the difficulties in the previous example.
1. Gift shares to Bob
To recap Groovy Train Ltd was worth €950,000 and Fred owns 110 shares and Bob owns 10 shares. Fred is 65 and will be 66 in June 2021. Fred’s shares are worth €870,870. The plan is now to pass the business onto Bob in the next 6 months or so. The first step is to transfer shares by gift to Bob. As Bob will now own more shares, he will take on more responsibility and Fred will ease back a bit. Fred decides to pass on 60 of his 110 shares to Bob now
Value of shares 60 x €7,917 €475,020
Less discount 25% €118,755 *
Net Value €356,265
Cost of shares €60
Gain €356,205
Retirement Relief €356,205
*Discount applies as Fred isn’t disposing of his full shareholding
Provided Fred meets the conditions for Retirement Relief read more here he wouldn’t pay any CGT on the gift. To avoid a clawback of Retirement Relief Bob needs to hold the shares for 6 years from the date of transfer. If Bob disposes of the shares within 6 years, he would pay the Capital Gains Tax that Fred didn’t pay. And he would also have to pay CGT on any increase in value on the value he got them for.
Fred could qualify for Entrepreneurs Relief if Retirement Relief doesn’t work Read here
Bob would pay 1% stamp duty on this initial transfer. This is due within 44 days of the date the transfer documentation is all signed off.
There would be no gift tax to pay on the basis that Bob would qualify for Business Property relief.
Value of shares 60 x €7,917 €475,020
Business Property Relief 90% €427,518
Taxable value 10% €47,502
This is well below the parent to child threshold of €335,000. But you will still need to verify what prior gifts or inheritances Bob got from his parents, if any.
Beware that there are clawbacks when it comes to Business Property Relief too. For more information Read here
2. Share buyback
It is now February 2020 and Fred is happy for two reasons. He is very happy that Bob is working very well in the business. This has allowed Fred more time to attend hurling matches. He is looking forward to seeing his beloved Kilkenny, recently crowned All-Ireland champions for 2020. He was very fortunate to get one of the 200 tickets for the final in Croke Park. It was an epic contest against Waterford the previous December. Fred is happy now to spend less and less time in the business and decides he would like to handover the rest of it to Bob.
His advisor thinks that the company could do a share buy-back. The company would buy Fred’s remaining 50 shares. It would then cancel those shares immediately. After that Bob would own 100% of Groovy Train Ltd as he would own all 70 shares.
The above transaction must benefit the trade of the company. If it does then a payment for shares is a capital payment. If treated as such, the payment would be liable to Capital Gains Tax [CGT] and not Income Tax. This is vital for Fred so he can avail of the CGT reliefs available. Older management making way for new management benefits the trade. Revenue takes this view and it is per their guidance on this issue. There are other conditions to meet too. To find out more on share buybacks Click here
Value of shares 50 x €7,917 €395,850
Less discount 40% €158,340 *
Net Value €237,510
Cost of shares €50
Gain €237,460
Retirement Relief €237,460
*Discount applies as Fred is disposing of a minority shareholding
On the disposal of his shares to the company, Fred can get the market value of those shares from the company. He is in a fortunate position that he doesn’t pay CGT on the proceeds and the company has the cash to pay him in full.
There would be no stamp duty on this transaction. Also, there is no gift tax as the company has paid him in full and so no gift element arises.
Fred has now successfully exited himself from the company. He can still work for the company in a reduced capacity for a period to help Bob. There is no set timeframe in law, but Revenue view a period of 6 months post buyback as being the correct amount of time.
3. Termination Payment
The company could pay Fred a termination payment when he leaves the company. There are certain Income Tax reliefs available on retirement or removal from employment. If the company pays Fred €12,540 that would be free from Income Tax as it would be less than Fred’s basic exemption. Let’s assume that Fred worked for Groovy Train Ltd for 30 years. His basic exemption would be as follows:
First €10,160
€765 X no of years’ service 30 €22,950
Total €33,110
Fred wouldn’t have a tax liability for this payment and the company should get a tax deduction for it.
Conclusion
We have looked at two possible ways for Fred to exit the business. Both achieve the desired result. Fred gets the money he wants, and the business goes to the next generation. In the example this week there wasn’t a need to get bank finance. Also, the company money could pay Fred for his shares. And Bob didn’t have to set-up a holding company to make the purchase. The best route to take will depend on the circumstances of the individual and if the company has cash or not.
Interested in finding out more about selling or transferring your business? Please call Deirdre on 051-396703 or contact us
